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Tuesday, December 11, 2007


morgan joins goldman on the call

recession is likely, via calculated risk, with a direct link here to richard berner's report.

We’re changing our calls for US growth and monetary policy. Since the shock of tighter financial conditions surfaced in August, we’ve incrementally reduced our outlook for future growth. But the time for incremental changes is over. A mild recession is now likely: We expect domestic demand to contract by an average 1% annualized in each of the next three quarters, no growth in overall GDP for the year ending in the third quarter of 2008 and corporate earnings to contract by 5-10% over that longer period. Three factors have tipped the balance to the downside: Financial conditions continue to tighten, domestic economic weakness is broadening into capital spending, and global growth — for us, long the key bulwark against a downturn — is slowing.

berner's change of view follows that of goldman's jan hatzius here and here.

for some time, optimistic views of the potential of home price declines have hinged on continued economic expansion in the united states and globally, both in terms of steady job growth and capital relief for american banks. i've considered those hopes probably futile in the face of the monstrosity of the credit bubble that is now beginning to unwind, and evidence enough to convince both hatzius and berner has apparently accumulated.

it's becoming more and more likely that house prices will fall very dramatically nationwide -- mean reverting by 30, 40, even 50% or more over the course of coming years as sources of credit and funding continue to be choked off. another step in that direction was recently taken by fannie mae as it attempts to limit its exposure to the markets most afflicted by asset deflation. this of course in tandem with washington mutual's expectation that 2008 nationwide mortgage origination will fall a stunning 40%. in these areas where prices most egregiously dislocated from incomes under the influence of gross credit underwriting distortions, i'd expect the unwind to be much more severe still. nationally and quite probably internationally, the result will be very damaging economically and financially if not (as is quite probable at times) disorderly and chaotic. and on an individual level, as freddie mac ceo richard syron is aware, a lot of tragedy will unfold.

While the mortgage crisis has brought a rising wave of foreclosure notices into public view, less evident have been "pictures of people standing with furniture on the lawn" after being forcibly evicted from their homes, Syron said. "As that begins to happen, and it will happen, I am afraid of the impact that this has."

much will depend on whether or not the united states government manages to effectively bail out its banks (to the likely tune of trillions of dollars in malinvestment, when all is said and done) and can somehow force both 1) a heavily-indebted consumer base to continue borrowing in the face of higher credit costs, and 2) a beleaguered financial system to continue offering credit in the face of higher risk. and do so while managing not to compel foreign creditors to flee american debt instruments (as they already may be moving toward).

if they can, it at best delays (again) an inevitable and overdue credit contraction for american society, making the ultimate outcome yet more disastrous. if not, i sincerely doubt there is much it will do to prevent a classic debt-deflation depression -- though not perhaps on the order of the great depression, at least comparable to previous depressions such as that of 1837, 1873 or 1893.

early signs are not good, as berner notes:

... compared even with a few weeks ago, financial conditions have tightened significantly further as the price of credit has risen and lenders have made credit less available. Money-market rates have risen significantly, and yield spreads over those money-market rates on loans have stayed high or widened. Three-month dollar Libor-OIS spreads have jumped by 60 bp to 100 bp over the past month, so that Libor rates in that tenor are merely 20 bp lower than where they were in the spring. Some of that jump in Libor rates reflects the transitory impact of year-end precautionary demands for liquidity. But we think that some also represents a more fundamental deleveraging and re-intermediation of the banking system that will last well into 2008 (see “Funding Pressures: More Fundamental than Turn of Year,” Global Economic Forum, November 19, 2007).

UPDATE: merrill's david rosenberg in on the fun too.

"We reiterate that real estate deflations are unique and have never ended well for the consumer, the credit market or the economy. We can identify only five periods post WWII when the real value of housing assets turned negative on a year-on-year basis. All of these time periods inevitably included a consumer downturn. Maybe it will be different this time, but we fail to see why," Mr Rosenberg concluded.

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